Auto Lenders Ramp Up Risk to Win More Customers

Interesting Wall Street Journal article talking about how loan terms continue to get longer and longer...

New risks are lurking in auto loans.

As loan growth slows, banks and other lenders have been tinkering with loan terms in an effort to gain more consumers. They are originating a greater share of loans with repayment periods of more than five years and, in some cases, extending loans to consumers who are stretching further to afford their purchases. Banks such as TD Bank, Santander Consumer USA Holdings Inc. and BB&T Corp. , meanwhile, have said they are increasing their loans to riskier applicants.

Their moves come at an unsettled time for auto lending. Sales growth has been choppy and missed payments are up from a year ago. Also, used-car prices are under pressure, raising the risk of higher losses for lenders when vehicles are repossessed. Faced with these headwinds, many lenders shunned applicants with low credit scores and have been looking for ways to make up the lost volume.

The latest underwriting efforts show that lenders, faced with conflicting signals about the health of the U.S. consumer, are engaged in a delicate balancing act to boost lending and profit without taking on overly risky customers. Though unemployment has reached an 18-year low and wages are creeping higher, some households are sliding deeper into debt and falling behind on their credit cards and other debt payments.

"[If] you only took on the financing for the top echelon of the super prime... [it’s] very, very hard to make money in and of itself,” TD Bank Chief Executive Greg Braca said at an industry conference this year.

Many auto lenders, including banks, nonbanks and the finance arms of car manufacturers, have been offering more loans with longer terms. Generally, these terms allow borrowers to make lower monthly payments, but usually at a higher interest rate. That, combined with the longer payment period, means that borrowers can end up paying thousands more for their cars than if they opted for a shorter loan.

In the first quarter, the average loan term for a new car exceeded 69 months, the second consecutive quarter it had ever been above that level, according to credit-reporting firm Experian. Also in the first quarter, new car loans originated with repayment periods of between 73 and 84 months represented more than a third of total new car loans, up from 7% of loans in late 2009.

Lenders say borrowers need flexible terms because new vehicles are getting more expensive. Despite the longer repayment periods, average monthly loan payments continue to rise, hitting a record $523 for borrowers who bought new cars in the first quarter, according to Experian.

Zac Craft wanted a three-year loan when he bought his 2012 Chevy Cruze this year but opted for a five-year loan despite its slightly higher interest rate. Mr. Craft plans to pay off the loan in three years to cut down on interest but wanted the option to make lower monthly payments when money is tight.

“There’s some security in that,” said Mr. Craft, who lives in Hawaii.

Lenders pushed into subprime auto lending after the recession, which helped boost vehicle sales. Subprime auto lending peaked at $114.4 billion in 2015, according to Equifax, accounting for 19% of auto loans and leases that year. Higher loan losses followed, and lenders subsequently tightened underwriting standards. That resulted in a drop in new car sales and loan originations last year.

While subprime lending is declining, some banks are turning to consumers whose credit scores are neither high nor low. TD Bank, Santander Consumer USA and BB&T say they have been extending more loans to borrowers they define as “nonprime” or “near prime.” Santander and BB&T also originate subprime auto loans.

Skeptics say the term nonprime is another way to label less-than-ideal borrowers without alarming investors. Nonprime and subprime customers can generate better returns because they tend to pay higher interest rates.

“When you can kind of operate in the belly of credit and generate 7-plus-percent yields on new originations, that’s pretty attractive business,” Ally Financial Inc. Chief Executive Jeffrey Brown said at an industry conference this month. Ally, one of the largest U.S. auto lenders, does business with borrowers across the credit spectrum, including subprime.

Lenders say they typically make the longest loans to prime customers who can afford them and understand the risks. A report last month by Moody’s Investors Service, however, found that borrowers who sign up for loans that last six years or longer have lower credit scores and owe a larger share of the vehicle’s price than consumers with shorter loans. The loan payments also account for a larger share of their income, said Moody’s, which reviewed loans securitized since 2017 and that were mostly comprised of prime borrowers.

At Ally, for example, borrowers with loans stretching six years or longer owed on average around 100% of the car’s purchase price when those loans were originated, according to Moody’s. Borrowers with a shorter repayment period owed 83%. Credit scores for borrowers with the longer loans averaged roughly 725, compared with about 760 for borrowers with shorter-term loans.
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A Ford Credit spokeswoman said the company’s lending standards haven’t changed and that longer-term loans are “a relatively small part of the business.” Honda Finance has kept its maximum repayment period at 72 months, a spokesman said.

Loans with longer repayment periods are more prone to default, according to Moody’s. Loans of five years or longer extended to borrowers in 2015 with high credit scores had a cumulative net loss rate of 1.29% as of spring 2017. For shorter-term loans, the loss rate was 0.28%.

More people would buy a 10k Mirage if it where not for these sub-prime loans lending people money to buy a 20k car even though they make too low of a salary. THose bums at Ally financed my Mirage at a 12.5% interest rate! And my FICo was around 575 at the time.

Now I am around 725 but they still wont lower my interest rate so I am just paying it off as fast as I can.

Just to give you an idea (and this is for a 9k loan) I paid almost $1000 in the first year just in finance charges. So even though I thought I had negotiated a slick deal at 9k purchase price in reality I am paying over 10k when you factor in the finance charges.

I got a 14.5% interest rate but they needed to verify my mom's cosign because she is a small business owner. So it dropped down to 4% even though I had virtually no credit.

Indeed. I wanted to inform people how much of an impact a high interest rate can make. Even in my example of a 9k car on a 5 year loan at 12.5% the finance charges for the first year where almost $1000 and that was with me paying 200$ per month on 175$ minimum payment.

So just imagine how much a guy would pay for a >20k loan at similar or higher interest rate. And imagine if same guy got loan that takes over 5 years to pay back? People could easily be paying DOUBLE the price of the car in the end if they make only the minimum payments.

In my case I took the offer because I felt I would pay off the entire loan in year one but sometimes "things come up" and the money has to be used for something else. The only good news out of that is that there will be more used cars available on the market as people abandon their loans and just allow the car to be repossessed.

Cars do tend to last a lot longer than they used to, though I'm not sure the average person KEEPS a car all that much longer than they used to. We all get distracted by the allure of shiny new stuff. Still, I'm stunned that the AVERAGE new car loan term is creeping up on 6 years! I remember when the standard options were "4 years or 5 years". Better rates for 5 years. And that was it.

Originally Posted by fc321

More people would buy a 10k Mirage.

I think more people would buy a Mirage if they did a seriously good no-haggle deal on both price and financing.

As it is around here, you walk in and they try to sell you not a $10k Mirage (they just advertise $10k in some places to get you in the door) but an $16-18k Mirage. They'll apply whatever discounts you qualify for and maybe get it around $11.5-12k if you're lucky. If you qualify for ALL of the discounts, you might see that $10k price.

But, if they could advertise a legitimate LOW PRICE and just give it to EVERYBODY, and build a reputation for doing that. Then they'd have something.

"The 2019 Mitsubishi Mirage, EPA rated at 42 mpg highway. Yours today, fully optioned, at any Mitsubishi dealer for $10,999. No strings, no haggling. $10,999. What color would you like?"

Back that up with stellar dealer financing, and make the purchase process EASY. Sell some cars.

The average new car nowadays is over $35,000. Not everyone has $800 a month to drop on a new Accord or Tacoma financed over four years. Manufacturers love extended financing because it keeps the expensive steel moving. Banks love it because they get an extra year or two of interest. Expect this trend to accelerate with rising interest rates and cars that are even more complex and expensive. It's a trend that makes me love my Mirage even more!

I financed my Mirage in December of 2014 72 months at 10.99%. It was always my intention to make double payments every month and pay the car off early, and that is exactly what I did. The low cost of the Mirage made the double payments pretty easy to handle. By December of 2017 I owned it. I did this rather than financing for three years because it would allow me to make the smaller payment...or even skip a payment...if there were ever a month or two where I got in a jam (and I did). Had I financed for three years I would have had to make the big payment no matter what.

A dealer in my area had a 17 base Mirage hatch for 169 a month zero out of pocket for 84 months. But you still have to pay tax, dmv, etc up front. Or you can buy it for cash for 11,995. 84 month payment on anything is nuts imagine how upside down you would be? Better have GAP Insurance.

The average new car price is now $36,000+ Check out this summary from KBB...

Unless you have less than stellar credit, nobody should be paying double-digit interest rates for a new/late model car. Join a credit union. Both credit unions I belong to will finance a 2015 or newer car for 3% up to 63 months. That's not free money...but it's close. You should always secure financing from an outside lender before you step foot onto the dealer's property. If you have to rely on the Finance Manager at the dealership to arrange financing, you're probably going to get hosed.

I got mine through a local Credit Union, 3.99% at 60 months. I believe at the time, my credit score was in the high 600s (just bought a house). But the Mirage was a crucial purchase as well as my other ride ate gas like crazy and was slowly falling apart.

In my opinion, people buying these brand new cars with long terms are buying these cars with little to no knowledge of the car, at least that's what I have seen around my town (friends and family). The people that fall for long terms are the ones going to the dealership and getting sold on a car that they will pay twice over for.